ACCTG 028
Accounting for Special Transactions
ACCOUNTING FOR LONG-TERM CONSTRUCTION CONTRACTS
Introduction
Construction Contracts provides requirements on the allocation of contract revenue and contract costs to
accounting periods in which construction work is performed. Contract revenues and expenses are recognised
by reference to the stage of completion of contract activity where the outcome of the construction contract can
be estimated reliably, otherwise revenue is recognised only to the extent of recoverable contract costs incurred.
Objective and Definition
The objective of Construction Contracts is to prescribe the accounting treatment of revenue and costs associated
with construction contracts.
What is a construction contract?
A construction contract is a contract specifically negotiated for the construction of an asset or a group of
interrelated assets.
Under Construction Contracts, if a contract covers two or more assets, the construction of each asset should be
accounted for separately if (a) separate proposals were submitted for each asset, (b) portions of the contract
relating to each asset were negotiated separately, and (c) costs and revenues of each asset can be measured.
Otherwise, the contract should be accounted for in its entirety.
Two or more contracts should be accounted for as a single contract if they were negotiated together and the
work is interrelated.
If a contract gives the customer an option to order one or more additional assets, construction of each additional
asset should be accounted for as a separate contract if either (a) the additional asset differs significantly from
the original asset(s) or (b) the price of the additional asset is separately negotiated.
What is included in contract revenue and costs?
Contract revenue should include the amount agreed in the initial contract, plus revenue from alternations in the
original contract work, plus claims and incentive payments that (a) are expected to be collected and (b) that can
be measured reliably.
Contract costs should include costs that relate directly to the specific contract, plus costs that are attributable to
the contractor's general contracting activity to the extent that they can be reasonably allocated to the contract,
plus such other costs that can be specifically charged to the customer under the terms of the contract.
Accounting Procedures
If the outcome of a construction contract can be estimated reliably, revenue and costs should be recognised in
proportion to the stage of completion of contract activity. This is known as the percentage of completion method
of accounting.
To be able to estimate the outcome of a contract reliably, the entity must be able to make a reliable estimate of
total contract revenue, the stage of completion, and the costs to complete the contract.
If the outcome cannot be estimated reliably, no profit should be recognised. Instead, contract revenue should be
recognised only to the extent that contract costs incurred are expected to be recoverable and contract costs
should be expensed as incurred.
The stage of completion of a contract can be determined in a variety of ways - including the proportion that
contract costs incurred for work performed to date bear to the estimated total contract costs, surveys of work
performed, or completion of a physical proportion of the contract work.
IAS 11: Accounting for Long-term Construction Contracts | 1
An expected loss on a construction contract should be recognised as an expense as soon as such loss is
probable.
Disclosures and Presentation
DISCLOSURES
1.
2.
3.
4.
amount of contract revenue recognised;
method used to determine revenue;
method used to determine stage of completion;
for contracts in progress at balance sheet date:
 aggregate costs incurred and recognised profit
 amount of advances received
 amount of retentions
PRESENTATION
1. The gross amount due from customers for contract work should be shown as an asset.
2. The gross amount due to customers for contract work should be shown as a liability.
Percentage of Completion Method
In accounting for long-term construction contracts (those taking longer than one year to complete), the two
methods commonly followed are percentage-of-completion and completed-contract.
The revenue recognized on a long-term construction contract under the percentage-of-completion method is
determined by applying a percentage representing the degree of completion to the total contract price at the end
of the accounting period. The percentage may be derived by dividing the costs incurred to date by the total
estimated costs of the entire contract based on the most recent information. The revenue so derived is then
reduced by the direct contract costs to determine the gross profit recognized in the initial period.
In subsequent periods, since the percentage-of-completion method described produces cumulative results,
revenue and gross profit recognized in prior periods must be subtracted to obtain current revenue and gross
profit to be recognized.
The percentage-of-completion method should be used when estimates of the bases upon which progress is
measured are reasonably dependable and all the following conditions exist:
1. The contract clearly specifies the enforceable rights regarding goods or services to be provided and received
by the parties, the consideration to be exchanged, and the manner and terms of settlement.
2. The buyer can be expected to satisfy all obligations under the contract.
3. The contractor can be expected to perform the contractual obligation.
4. The completed-contract method should be used when inherent hazards or lack of dependable estimates
cause the forecasts to be of doubtful value.
Under the percentage-of-completion method, a schedule is made of the contracts in process, showing the total
costs incurred as of the end of a given period, the estimated gross profit recognized based on the degree of
completion, and the total billings rendered on each individual contract. If costs incurred plus recognized profits
exceed the related billings on a contract, this net figure is shown as a current asset. This treatment shows that
the contractor has not fully billed the customer for work performed to date and has a claim against the customer
for that portion of work completed but not yet billed. If billings on a contract exceed costs incurred plus estimated
profits, this net figure is shown as a current liability, which means that the contractor has overbilled the customer
for work done to date and must complete the work represented by the excess billings.
Completed-contract Method
Under the completed-contract method, no earnings are recognized until the contract is substantially completed.
For the period in which completion occurs, gross revenues include the total contract price. Total job costs
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incurred are deducted from gross revenues, resulting in recognition of the entire amount of gross profit in the
completion period. If it is expected that a loss will occur on the contract, a provision for loss should be recognized
immediately under both the completed-contract method and the percentage-of-completion method.
Under the completed-contract method, the treatment of excess costs and billings is the same as under the
percentage-of-completion method except that estimated profits are not computed because profit recognition is
deferred until a contract is completed. The excess of costs over related billings on a contract is a current asset
while the excess of billings over related costs on a contract is a current liability
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